What do we lose if the car industry is allowed to fail?

A car production line at the Holden Elizabeth plant in Adelaide. What do we lose if Australia's car industry collapses?

ABC News

An agreement by Holden workers yesterday to accept a wages freeze once again highlighted the financial trouble facing the car industry in Australia and the tough calls needed to keep it operating. It's a battle worth fighting, argues Phillip Toner.

The difficult decision yesterday by Holden car workers to accept a wages freeze in return for job certainty until 2016 provides a good time to consider how the industry got into this parlous state and why the taxpayer commits scarce resources to supporting such a troubled industry.

The Australian auto industry is under extreme pressure from imports and is suffering significant decline in market share as well as in the actual volume of cars produced.

The total annual production of Australian-made vehicles for the domestic and export market for is now just over 200,000 vehicles. But if we look back several years that figure is over 300,000. That is a substantial reduction in the volume of production.

In turn, this is adversely affecting the competitiveness and profitability of the industry which benefits greatly from scale economies – the more cars produced the cheaper they become.

So what's driving the decline?

The decline in the numbers of cars made in Australia is caused by a combination of factors but chief among them is the high Australian dollar. Even now, at its current level of the low $US90c range, the exchange rate is hurting the local car industry. This is a very important point to make.

If the Aussie dollar was at the long term average of around $US75c locally made cars would be around 20 per cent more competitive against imports and in export markets.

The value of the dollar is out of whack with economic fundamentals, particularly the level of productivity in the Australian economy when compared with other countries. It has been recognised by leading international economic agencies such as the OECD, World Bank and IMF that, following deregulation of currency markets in 1970s, it was naive to hope that exchange rates would balance capital and trade flows across nations.

But the local car companies are also at fault, stuck as they are in making mostly medium-to-large sedans.

Toyota, Ford and Holden make fantastic rear-wheel family cars and the local makers are recognised as the global seat of expertise in that style.

The problem is that sales of this style of vehicle are in steep decline. Smaller vehicles (with under two-litre engines) as well as utes and 4x4s together account for close to 80 per cent of total sales. Australia produces very few of these types of vehicles. There is a strange failure by the industry to adapt to change in the local market and this failure must reflect adversely on management.

Yet it is not entirely without explanation.

Profit margins on large vehicles are higher, and there is an element of technological 'lock in' - you keep on producing what you are good at despite a changing environment.

Government policy, too, has failed to take up its role in effecting change.

Instead of offering a subsidy for production, the government could have been more forceful in shifting local production to match local demand.

Many people tend to think that private firms are nimble and highly adaptable, but remember the giant US car industry was almost brought to knees in the 1970s and 80s by a failure to respond to the small car, high quality revolution introduced by the Japanese.

In turn, the US government extensively bailed out its major car makers including Chrysler, General Motors and Ford.

What do we lose if Australia's car industry collapses?

The orthodox economic argument goes that the car industry should be let go because it's unproductive, or less productive than other industries. This argument contends that productivity in Australia would be enhanced if labour and capital is reallocated to other industries.

However, the great irony is that if we look at the way productivity is measured – as value-added per worker – then the Australian car industry's productivity is substantially above average. ABS data shows that productivity in the Australian car industry sits at something over $100,000 per worker, compared to around $85,000 across the economy. (Information available here and here)

Calling for the withdrawal of support for the car industry could bring about its demise, and with it, a reduction in average productivity in the Australian economy.

This speaks to a broader issue – some of my recent research indicates that about 80 per cent of net employment growth in the Australian economy over the past two decades has been in industries with substantially below-average productivity per worker.

As we shift towards a service economy the industries that are growing in employment are the low productivity industries. This has major implications for income distribution, growth of real wages and growth of taxation.

This is an important development that isn't getting the attention it deserves. The car industry serves as a nice example of this in action: if you shut the industry down because of policy indifference you end up cutting productivity per worker across the economy.

Another important point is the impact on research and development.

The car industry spends over $600 million per year on R&D. The rate of expenditure has grown rapidly despite production volume declining. It's not realistic to assume that somehow if Holden, Ford, Toyota leave Australia that the car components sector will survive and thrive.

While there are individual examples of component makers operating in countries without a car manufacturing industry, there are only rare examples of large scale components makers existing without a domestic car manufacturing industry.

Component makers work closely with car manufacturers every time a new model is developed - everything from the seating to the look of the instrument panel - and it requires a physical proximity to effect change efficiently.

What we're potentially looking at is the loss of an important part of Australia's technological base because of the sheer breadth of technologies that are involved in the production of a motor vehicle: metallurgy such as complex casting of alloys; sophisticated machining centres; electronics and software into engine management and safety systems; robotics used in assembly and painting; chemicals and paints; sophisticated work organisation and logistic systems and of course the trade, technician and engineering skills supported by the car making industry.

It comes as something as a shock to most people when I argue that Australia is not a particularly advanced technology country. We cannot afford to lose the technological capacity embodied in the car industry.

Phillip Toner is a senior research fellow in the Department of Political Economy at the University of Sydney. View his full profile here.